Black Swan fund manager sees ‘Tinderbox time bomb’ in financial markets

(Bloomberg) — Universa Investments, a hedge fund consulted by Black Swan author Nassim Taleb, has told clients that inflating debt in the global economy could hurt markets rivaling the Great Depression.

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“This is objectively the greatest time bomb in financial history — more powerful than the late 1920s, and probably with similar market effects,” Mark Spitznagel, 51, the firm’s chief investment officer, wrote in a letter to investors received by Bloomberg this week.

On Friday, Treasury Secretary Janet Yellen said she was pleased with US employment and inflation data, but didn’t want to play down the risks of a recession. While the Bloomberg Economics model puts a 100% chance of a recession this year, some are predicting a moderate downturn due to a strong labor market and declining inflation.

Universa is a so-called tail risk fund designed to protect investors in the most difficult market conditions. These types of funds have an incentive to anticipate dire economic conditions as they thrive during market downturns.

“Too Credited”

Spitznagel has long been a critic of central banks for too low interest rates, predicting last year that “if this credit bubble ever bursts, it will be the most catastrophic market crash anyone has ever read about.”

In a letter this week, he added fiery new rhetoric about the level of global debt. “Correction that was once natural and healthy has instead turned into a contagious hell that can completely destroy the system,” he wrote. “Today the world is too leveraged, the debt structure is too big.”

Hedge fund managers lost more than $200 billion last year, according to LCH Investments, sparking a debate about how to prepare for the downturn. Universa’s strategy could have an average return on investment of 402% if the S&P 500 were to fall 10% in a month, Spitznagel said. That same gain could be 10,251% if the index falls 30%, the letter says.

“This payback profile is Universa’s core competency,” Spitznagel said. “We’ve been perfecting it for decades.”

According to the letter, if the investor allocates 2% of its portfolio to Universa, its compound annual growth rate will be 10.4% over the past five years. The total return of the S&P 500 from January 30, 2018 to January 30, 2023 was over 55%.

Universa did not elaborate on its 2022 returns, with the S&P 500 ending the year down 19.4%.

Even last year “wasn’t particularly favorable, but our extra bowstring more than made up for it in other years,” he said.

doomsday predictions

Spitznagel and Taleb have raised the alarm about the economy before, and not every doomsday prophecy comes true.

In October 2013, Spitznagel told CNBC that the market was poised for a “major crash” and could drop as much as 40%. Despite periods of market volatility, the S&P 500 generally rose until March 2020, when it plummeted after the pandemic shut down the global economy.

Although Spitznagel predicts a depression-like recession this year, many analysts and economists believe that the economic downturn will not cause much damage to the US economy. Moody’s Analytics Chief Economist Mark Zandi wrote this month that the US economy will avert an all-out recession but face rising unemployment and slowing growth.

“Let’s call it a slow concession,” he wrote.

The Federal Reserve will release its next decision on Wednesday and is expected to raise interest rates by a quarter of a point.

(Updates with the Fed’s decision in the last paragraph. Janet Yellen’s last name was corrected in a previous version of this story.)

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